China retools bank reserve ratio, casting doubt on more RRR cuts to stoke lending

[BEIJING] As investors continue to grapple with China's economic slowdown, regulators may be taking away an old standby for monetary easing.

The required reserve ratio (RRR) for commercial banks, a tool long used to add or remove liquidity, will increasingly be used instead as a lever for enforcing financial stability. That's according to a People's Bank of China announcement on Dec 29 describing a new Macro Prudential Assessment system, or MPA.

The idea is to use the ratio of deposits that must be held at the PBOC as a method for reining in risks. Exposure to stock and bond markets will be used in calculating ratios for individual banks, the PBOC says. Officials will also look at growth in lending, rates on loans and capital adequacy.

Among the potential implications: less likelihood of required reserve ratio cuts as a way of stoking lending growth amid the weakest economic expansion in a quarter century.

China's main stock index tumbled so much on Monday that circuit breakers halted trading, offering a reminder of how poor sentiment is even after equities in recent months recouped some of last summer's rout. The PBOC injected liquidity on Tuesday through repurchase agreements, helping shore up some stabilisation in stocks.

"We'll see less across-the-board cuts" in the RRR, said Ming Ming, head of fixed income research at Citic Securities Co in Beijing who formerly worked in the PBOC's monetary policy division.

"The MPA framework signals policy makers will move away from universal reserve ratio changes to being in favor of using the tool to fine-tune requirements for individual banks." The change is part of a broader shift toward more flexibility with monetary policy tools as China tries to balance economic reforms with propping up growth. Central bank researchers have advocated setting up an interest-rate target similar to what the US Federal Reserve has used.

Ma Jun, the chief economist of the PBOC's research bureau, said in a commentary last Wednesday the central bank should set reserve requirements with short-term interest rate stability in mind and pointed to open market operations and other facilities to manage rates. China's 10-year bonds dropped the most in two weeks after Ma's comments damped speculation that lenders' required-reserve ratios will be eased further.

The required-reserve ratio forces banks to put aside a percentage of their deposits that they can't lend out, which directly affects the cash supply in the banking system. It's a monetary tool that the US Federal Reserve has long since stopped using to adjust liquidity in the economy. The PBOC currently pays a 1.62 per cent annual interest rate on banks' required reserves and 0.72 per cent on extra reserves parked at the central bank.

Chinese policy makers last announced a cut in the ratio for the biggest banks in October, reducing it to 17.5 per cent from 18 per cent, while also lowering the one-year lending rate, their main policy tool, to a record low 4.35 per cent. In a series of reductions, the central bank has brought the reserve ratio down from its 2011 peak of 21.5 pe rcent.

The easing underscored the determination of the country's leaders to meet their 2015 growth goal of about 7 per cent. The pace of expansion will slow to 6.5 per cent in 2016 and 6.3 per cent in 2017, according to the median estimates of economists surveyed by Bloomberg.

Market participants say short-term liquidity is tightening and capital outflows continue, making the PBOC more likely to add liquidity, according to a report on Tuesday by the official China Securities Journal, an affiliate of Xinhua News Agency. The participants, who weren't identified, said additional RRR cuts are necessary and feasible, the paper said. Economists had expected one more RRR cut by Jan 1, according to the median of estimates in a Dec 17 to Dec 22 Bloomberg survey.

The central bank said in its announcement last week it will use the new MPA system to examine banks' capital adequacy and watch financial institutions' interest-rate pricing, the monetary authority said last week. The PBOC will assess data quarterly, while monitoring and giving guidance to banks on a monthly basis.

The PBOC said the assessment "will change its focus from loans, which are narrowly defined, to a focus on credit in a broader sense." It will include bond investments, equity investments and buybacks of financial assets sold - which typically refers to banks' off-balance-sheet assets.

BLOOMBERG